Another Asian wake-up call

04:45 AM Nov 30, 2011
by Stephen S. Roach

For the second time in three years, global economic recovery is at risk. In 2008, it was all about the subprime crisis made in America. Today, it is the sovereign-debt crisis made in Europe. The alarm bells should be ringing loud and clear across Asia - an export-led region that cannot afford to ignore repeated shocks to its two largest sources of external demand.

Indeed, both of these shocks will have long-lasting repercussions. In the United States, the American consumer (who still accounts for 71 per cent of US GDP) remains in the wrenching throes of a Japanese-like balance-sheet recession.

In the 15 quarters since the beginning of 2008, real consumer spending has increased at an anemic 0.4 per cent average annual rate. Never before has America, the world's biggest consumer, been so weak for so long.

Until US households make greater progress in reducing excessive debt loads and rebuilding personal savings - a process that could take many more years if it continues at its recent snail-like pace - a balance-sheet-constrained US economy will remain hobbled by exceedingly slow growth.

A comparable outcome is likely in Europe. Even under the now seemingly heroic assumption that the euro zone will survive, the outlook for the European economy is bleak. The crisis-torn peripheral economies - Greece, Ireland, Portugal, Italy, and even Spain - are already in recession. And economic growth is threatened in the once-solid core of Germany and France, with leading indicators - especially sharply declining German orders data - flashing ominous signs of incipient weakness.

Moreover, with fiscal austerity likely to restrain aggregate demand in the years ahead, and with capital-short banks likely to curtail lending - a serious problem for Europe's bank-centric system of credit intermediation - a pan-European recession seems inevitable. The European Commission recently slashed this year's GDP growth forecast to 0.5 per cent - teetering on the brink of outright recession. The risks of further cuts to the official outlook are high and rising.

It is difficult to see how Asia can remain an oasis of prosperity in such a tough global climate. Yet denial is deep, and momentum is seductive. After all, Asia has been on such a roll in recent years that far too many believe that the region can shrug off almost anything that the rest of the world dishes out.

If only it were that easy. If anything, Asia's vulnerability to external shocks has intensified. On the eve of the Great Recession of 2008-2009, exports had soared to a record 44 per cent of combined GDP for Asia's emerging markets - fully 10 percentage points higher than the export share prevailing during Asia's own crisis in 1997-1998.

So, while post-crisis Asia focused in the 2000's on repairing the financial vulnerabilities that had wreaked such havoc - namely, by amassing huge foreign-exchange reserves, turning current-account deficits into surpluses, and reducing its out-size exposure to short-term capital inflows - it failed to rebalance its economy's macro structure. In fact, Asia became more reliant on exports and external demand for economic growth.

As a result, when the shock of 2008-2009 hit, every economy in the region either experienced a sharp slowdown or fell into outright recession. A similar outcome cannot be ruled out in the months ahead. After tumbling sharply in 2008-2009, the export share of emerging Asia is back up to its earlier high of around 44 per cent of GDP - leaving the region just as exposed to an external-demand shock today as it was heading into the subprime crisis three years ago.

China - long the engine of the all-powerful Asian growth machine - typifies Asia's potential vulnerability to such shocks from the developed economies. Indeed, Europe and the US, combined, accounted for fully 38 per cent of total Chinese exports in 2010 - easily its two largest foreign markets.

The recent data leaves little doubt that Asia is now starting to feel the impact of the latest global shock. As was the case three years ago, China is leading the way, with annual export growth plummeting in October 2011, to 16 per cent, from 31 per cent in October 2010 - and likely to slow further in coming months.

In Hong Kong, exports actually contracted by 3 per cent in September - the first year-on-year decline in 23 months. Similar trends are evident in sharply decelerating exports in Korea and Taiwan. Even in India - long thought to be among Asia's most shock-resistant economies - annual export growth plunged from 44 per cent in August to just 11 per cent in October.

As was true three years ago, many hope for an Asian "decoupling" - that this high-flying region will be immune to global shocks. But, with GDP growth now slowing across Asia, that hope appears to be wishful thinking.

The good news is that a powerful investment-led impetus should partly offset declining export growth and allow Asia's landing to be soft rather than hard. All bets would be off, however, in the event of a euro zone break-up and a full-blown European implosion.

This is Asia's second wake-up call in three years, and this time the region needs to take the warning seriously. With the US, and now Europe, facing long roads to recovery, Asia's emerging economies can no longer afford to count on solid growth in external demand from the advanced countries to sustain economic development.

Unless they want to settle for slower growth, lagging labour absorption, and heightened risk of social instability, they must move aggressively to shift focus to the region's own 3.5 billion consumers. The need for a consumer-led Asian rebalancing has never been greater.

Stephen S Roach, non-executive chairman of Morgan Stanley Asia, is a member of the faculty of Yale University and the author of The Next Asia.